One other gem in Richard Templar’s The Rules of Wealth/Money is the rule about not surrendering equity. This rule is handy not only for business owners but for investors also.
If a business owner truly believes that her business is viable and strong, she would be very hesitant about giving a piece of it away. If she had an option of borrowing to finance or going to the equity markets, she would do all she could to avoid the equity market route.
There are exceptions…when the regular lenders are tapped out, when the purpose (like buying another company) is too big for borrowing, when interest rates are unbearably high, when the owner wants to cash out (partially or completely – often the reason for IPO’s) but an investor should always ask herself “why is the business owner giving away equity?”
Just as the business owner should ask “why would I want to give away profits?”
This applies to companies giving away divisions also. Sometimes the rationale is focus (or the parent company is struggling and needs cash or…) but often the reality is that the parent company management believes they’ll get more cash by selling than by running the subsidiary itself. That is a caution sign to buyers that they might be overpaying.
If business owners have to go to the equity well, Templar suggests that they only swap equity for…
“-business skills and acumen
-hands-on directorships
-a freedom-from-hassle agreement so you can run the business the way you want
-a realistic percentage so you don’t give away too much
-a buy-back clause so you can buy back the equity for cash at a later stage when you are cash rich.”
He also states in bold “never give voting shares to anyone.” The shares he offers investors are non-voting (personally I would never invest in non-voting shares regardless of the company).